Mortgage Crisis: The Principal Cram-Down and Amnesty Proposal

It took over a decade of greed, hubris and regulatory failure to freeze the housing market. Solutions cannot take that long.

Of course, some homes just need to be torn down, and some people need to be sanctioned.

There are millions of homeowners whose homes are worth less than they owe on their mortgages. They can’t sell their homes and they have reduced incentives to maintain their property, which brings down the value of surrounding properties. The solution is principal cram-downs of first mortgages to 95 percent of the value of homes and releases of all second mortgages (they are worth nothing today) on underwater homes. Borrowers need some skin in the game and owners of mortgages should benefit when the market recovers. To achieve this, the owners of first mortgages should receive second mortgages for the amount of the cram-downs. When a borrower sells her home, the holder of the second mortgage and the borrower will equally share any appreciation over the value of the home at the time of the cram-down, but the mortgage holder cannot receive more than the principal amount of the second mortgage. Under this cram-down proposal, borrowers would not be completely bailed out and would have an incentive to keep their homes and maintain their property. Compared to foreclosure, lenders would take smaller hits to their balance sheets, and society would benefit because homes would be occupied and cared for by either the original or new owners.

On the demand side, people are reluctant to buy foreclosed properties, particularly in nonjudicial foreclosure states, because banks’ shoddy (and sometimes fraudulent) paperwork has made it difficult for potential buyers to know whether they are getting good title to the property. Declare an amnesty. For a certain period of time, holders of mortgages can go to court to foreclose even if they cannot provide the full documentation they should have for foreclosures (the details would have to be ironed out). At the same time, the foreclosing entities would have to contribute to a fund that would compensate people who were wrongfully foreclosed upon as well as any mortgage holders who could prove that they — and not the foreclosing entity — were the actual owners of the foreclosed mortgage.

These two proposals don’t solve all the problems. In some places there are too many homes, and not enough people. There we need teardowns. There are borrowers whose loans will become unaffordable once interest rates start rising. For them, refinancing programs are needed. And, there are the people who are to blame for this mess. For them, we need sanctions.